The Investor's Propensity Towards a Type II Error in the Going Concern Assessment: An Econometric Evaluation of the Relationship Between Management's Good News and Financial Stress in Public Entitie

The high rate of Type II error in the auditor's opinion on an entity's ability to continue as a going concern emphasizes the enhanced decision-making responsibility of the rational investor in determining whether an entity will continue operations based on publicly available information. Extant studies on the going concern phenomena confirm that less than half of the entities that file for bankruptcy protection received a going concern modification in the Report of the Independent Registered Public Accounting Firm. Surprise bankruptcies result in countless losses to the investor and the public.;In the absence of proprietary information, the investor must discern whether a financially distressed entity will continue operations. This assessment is difficult because despite evidence of financial distress, management generally uses wording and phraseology on Form 10-K or Form 20-F that is largely optimistic and noncommittal about the future. Additionally, projected performance is permissible under the protection of forward looking statements. One significant challenge in today's economic environment is correctly identifying which entity amongst many that exhibit evidence of financial distress in tandem with management's good news disclosures, will fail.;Bankruptcy and going concern predictive models are highly accurate in identifying entities at risk of failure; however, there are few studies that focus on the impact of management's good news disclosures on bankruptcy outcomes. This study focuses on management's good news disclosures for a sample of financially distressed bankrupt and non-bankrupt entities.;A multivariate logistic test was developed to examine the association between management's good news disclosures and bankruptcy for a sample of financially distressed entities. Seven regressed variables were revealed to be statistically significant; however, predictor variables normally associated with going concern prediction studies were not found to be statistically significant. It was further discovered that management's disclosures across the sample of financially distressed bankrupt and non-bankrupt entities, lacked information content. The results of the study confirmed that an investor can have fewer instances of a Type II error if attention is given to management's disclosures; however, management's disclosures are not useful in contradicting evidence of bankruptcy.